W. R. Berkley Corporation — Q2 2018 Form 10-Q
Business context and reporting period
W. R. Berkley is a global property-and-casualty insurance holding company operating through Insurance and Reinsurance segments, alongside corporate and non-insurance businesses. This unaudited filing covers the quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods unless noted. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenues | $1,910.9m | $1,848.0m | $3,802.2m | $3,718.5m |
| Net premiums written | $1,624.1m | $1,564.3m | $3,289.4m | $3,211.1m |
| Net premiums earned | $1,581.1m | $1,568.7m | $3,148.5m | $3,138.7m |
| Net investment income | $153.8m | $135.3m | $328.3m | $284.1m |
| Income before income taxes | $229.2m | $161.0m | $440.2m | $345.3m |
| Net income to common stockholders | $180.1m | $109.0m | $346.5m | $232.5m |
| Diluted EPS | $1.40 | $0.85 | $2.70 | $1.81 |
| Consolidated GAAP combined ratio | 94.9% | 95.1% | 94.8% | 95.4% |
Q2 net income rose 65%; first-half net income rose 49%. Management attributed the first-half increase principally to higher investment income, investment gains, underwriting income and foreign-currency gains, and lower tax expense. The first-half effective tax rate was 20.9%, versus 32.2% in 2017, primarily reflecting the reduction in the U.S. federal corporate rate from 35% to 21%.
Material changes and operating trends
- Q2 gross premiums written increased 3% to $1.95bn; first-half gross premiums increased 3% to $3.93bn. Insurance growth was partly offset by lower Reinsurance premiums. First-half net premiums earned were up less than 1%.
- Average renewal premium rates, adjusted for exposure changes, increased 1.5% in Q2 and 2.5% for the first half. Renewal retention was 76.6% for policies expiring in the quarter and 75.9% for the first half, below the comparable 2017 rates of 77.2% and 76.5%.
- First-half net investment income increased 15%, with management citing fixed-maturity portfolio growth, higher interest rates and greater income from investment funds. Investment gains were $118.1m versus $92.8m; 2018 gains included $267m of realized investment-sale gains, partly offset by $149m of unrealized losses on equity securities.
- First-half consolidated loss ratio was 61.5% versus 61.9%; expense ratio was 33.3% versus 33.5%. Insurance’s first-half combined ratio was 93.9%; Reinsurance’s was 104.2%, an underwriting loss despite improvement from 108.7% in 2017.
- Catastrophe losses, net of recoveries and reinstatement premiums, were $21m for the first half versus $47m. Favorable prior-year development, net of premium offsets, was $19m versus $24m: Insurance had $26.5m favorable development, partly offset by $7.2m adverse development in Reinsurance.
Cash flow, balance sheet and capital
- Operating cash flow was an outflow of $119.4m in the first half, compared with a $224.9m inflow in 2017. Management cited timing of claim payments, long-term incentive payments and tax payments. Investing activities used $216.4m; financing activities provided $114.4m.
- At June 30, cash and cash equivalents were $911.2m; total investments were $17.60bn. The company stated that approximately 76% of its investment portfolio was in cash, cash equivalents and marketable fixed-maturity securities and described the portfolio as highly liquid.
- Total assets were $24.62bn and total equity was $5.47bn. Stockholders’ equity was $5.43bn, or $44.58 per outstanding share. AOCI shifted from $68.5m income at year-end 2017 to a $395.8m loss, reflecting investment and currency translation losses.
- Debt carrying value was $2.70bn, with face amount of $2.74bn. Debt represented 33% of total capitalization, versus 32% at year-end. The company issued $185m of 5.70% subordinated debentures due 2058 and $22m of subsidiary debt during 2018; interest expense increased to $76.8m for the first half from $73.6m.
- Net loss reserves were $10.08bn and gross reserves were $11.74bn. The company repurchased 101,000 shares for $6.8m in the first quarter and none in Q2.
Outlook, commentary and risks
- The filing provides no specific earnings or revenue guidance. Management said recent premium-rate increases will be earned over subsequent quarters and maintained a shortened fixed-maturity portfolio duration of 2.9 years to limit mark-to-market sensitivity and position for rising rates.
- Management expected Argentina to be considered highly inflationary under GAAP effective July 1, 2018, subject to that conclusion being confirmed. If so, the company expected to change the Argentine operation’s functional currency to the U.S. dollar and recognize foreign-exchange gains or losses on non-dollar transactions in earnings.
- Key risks include the cyclical insurance market, competition and pricing, catastrophe losses, reserve-estimation uncertainty and long-tailed claims, investment and interest-rate risks, foreign-currency and political risks including Brexit, reinsurer collectability, and legal, regulatory, technology and data-security risks. The company reported no material change to the risk factors in its 2017 Form 10-K.
- Fixed-maturity securities had $159.5m of gross unrealized losses at June 30, up from $60.2m at year-end. Management attributed losses primarily to temporary market and sector factors, said affected securities were not delinquent or in default, and did not consider them other-than-temporarily impaired.
- Ordinary-course insurance and reinsurance disputes, litigation and arbitration are considered in loss reserves. Management did not expect ultimate liability to be material to financial condition, while noting adverse outcomes could materially affect results in an individual period.
- Accounting changes effective in 2018 included recognition of fair-value changes on covered equity investments in earnings, increasing volatility in reported investment gains. Adoption-related cumulative adjustments principally reclassified amounts between retained earnings and AOCI; the filing reports no net impact to total stockholders’ equity from the cited financial-instrument and stranded-tax-effect adjustments.
Important facts for investors to verify
- Whether premium-rate increases and renewal trends translate into sustained earned-premium growth and underwriting profitability.
- Whether favorable Insurance reserve development continues, and how Reinsurance adverse development and long-tail claims evolve.
- Drivers of the operating cash-flow decline and whether cash generation normalizes as claim and tax-payment timing changes.
- The composition, duration, credit quality and unrealized-loss exposure of the investment portfolio, including alternative investments and real estate development commitments.
- The effect of new debt and the expected Argentina functional-currency change on interest expense, earnings and AOCI.
- Any developments in litigation, reinsurance recoverables, or other contingencies that could affect reserves or period results.